Mester: Would "Wait and See" on Rate Cuts as Fed Must Be Restrictive to Reach Inflation Target
Former Cleveland Fed President says jobs data show "uneasy balance" in labor market, more Fed officials may see policy "calibrated" now, need to wait wait for more data
Loretta Mester had a nearly four decade career in the Federal Reserve system, starting at the Federal Reserve Bank of Philadelphia in 1985, where she rose through the ranks to be the Director of Research and Chief Policy Advisor in 2010. That’s where I first met her, when I went to Philadelphia to interview her boss, then-president of the Philly Fed, Charles Plosser, and she agreed to do an interview with me too.
Fast forward to 2025. Loretta, who retired from as president of the Cleveland Fed last year, where she was well known and widely respected as a thought leader on maintaining price stability and keeping inflation in check, joined me in Philadelphia again to discuss the Fed and its policy path. This time we talked as she was on an important panel at thAmerican Economic Association’s annual conference, The Future of the Fed.
We started with the Near Future of the Fed as I asked her about the coming release of the December employment report, what she expected to see and more important how her former colleagues on the policymaking Federal Open Market Committee would react to it.
Point One: A single data point won’t be definite on next policy decision.
”I think of the data as sort of a disciplining device on checking… whether the Fed policymakers view is consistent with the data…looking at the payroll report… that informs them about the economy…and their forecasts about where the economy is going that will be important in determining what they’ll do with interest rates.”
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Point Two: The labor market is in an “Uneasy Balance”
“We have seen the unemployment rate tick up. And I think that’s the focus of many Fed policymakers is whether we will see a more material, increase in the unemployment rate and a more material softening in the labor market
Point Three: Time to wait and see on more rate cuts
If the Fed is serious about getting inflation back down to 2%, they are going to need to have policy “somewhat restrictive.” And after doing three rate cuts, more members of the FOMC may be ready to pause “and see how the economy is evolving.”
As for the Future of the Fed this year and beyond, Loretta says the Fed must start embracing uncertainty in the policy paths it sets, and also offer not only what it expects to do but also “scenarios” of what it may have to do if the actual path of the economy changes.
On the question of fiscal dominance, she says it’s not here yet, and even though inflation has come down a lot from the lofty levels hit in the pandemic, there’s risk of the fiscal dominance reaching “dangerous territory” where “monetary policy isn’t able to just to focus on it’s dual mandate goals.”
So dive in and hear what Loretta has to say on all of these issues and more. She says if she were still on the FOMC, she would vote to wait and see more rate cuts. After you hear what she has to say, let me know if you would, too.
Data issues and the Fed: Employment report coming… 00:01:14:18
Well, I mean, the Fed has to use the data that’s available. But the Fed also knows that data is subject to revision. So again, you know, they’re going to take that job report and they’re going to look and see whether it’s telling them about payroll growth about the unemployment rate. And you know, all data are measured with some error. And they’re going to take that into account when they’re doing the their policymaking. I, I want to emphasize that one report should not be changing policymakers’ view of the economy. The data informs them about the economy and how it’s evolving. So I think of the data as sort of a disciplining device on checking, you know, whether the Fed, policymakers view is, is consistent with the data, making sure that the data disciplines any kind of judgment that they bring to bear in making policy. And it’s looking at the payroll report, along with a lot of other data that informs them about the current economy and also… their forecasts about where the economy’s going. That’ll be important in determining what they’ll do with interest rates.
Dual Mandate Fed… but inflation IS STILL overshooting 00:03:16:10
Well, the fed has a dual mandate. It’s price stability, of course, and we’ve interpreted that as being 2% inflation and maximum employment now. So they have to be looking at both parts of that mandate whenever they’re making a policy decision recently. Right. As you say inflation is still above 2% and it’s been above 2% for almost five years now. Right? Certainly the inflation rate has come down from the peaks that we saw in the post-pandemic period, but it’s still running above 2%. And my own view is that there isn’t enough evidence to suggest that even if you take tariffs out, which I know the Fed has said that they’re going to look through this tariff, increase prices, that inflation ex those tariffs is on its way down to 2%.
Fed now should emphasize the inflation side of the mandate 00:04:07:23
So to my mind I have to be putting a lot of, you know my concern on the inflation side of the mandate. But we also have to say that we have seen softening in the labor market. What’s tricky about it is that there’s both demand side and supply side factors driving that softening. Right. So certainly firms are not hiring as much as they were before.
Is some of job market weakness ‘margin preservation’ by firms? 00:04:33:18
If you look at openings, they’ve been going down. And, you know, the firms are just trying to sort of preserve margins. I think in the wake of those higher tariffs. And so they’re going to be cautious about hiring. And then there’s also some firms that are sort of putting a lot of weight on AI and other kinds of fact technological changes to help them limit, right, how many people they need to actually do their job.
Supply side issues: Immigration policy 00:04:59:03
On the supply side, the immigration policy that you mentioned is being is important. Right. So we’ve seen a strong decline in the rates of immigration and that has limited the supply labor. So I like to say that the labor markets, in this uneasy balance, we have firms not hiring as robustly. And certainly that’s softening. But we also have fewer supplier workers.
An uneasy labor market balance 00:05:23:06
So the labor markets in a kind of uneasy balance, we have seen the unemployment rate tick up. And I think that’s the focus of many Fed policymakers is whether we will see a more material, increase in the unemployment rate and a more material softening in the labor market. I would still put the emphasis on the inflation part of the mandate. I think the labor market could… could… basically be in this sort of stasis for a few months longer. But we’ll have to see.
I’d be in the ‘Wait and See’ camp 00:06:40:05
Well, if I were still on the committee, I would be in the camp of let’s wait and pause and see how the economy’s going to evolve, because I am concerned that if they do continue to cut interest rates, they will quickly be neutral and move beyond neutral. And if you really are serious, and I think the Fed is about being committed to getting inflation back down to 2%, you’re going to need to have policy somewhat restrictive. So in order to do that. So I think there’s going to be now that they’ve cut the three times, I think there are going to be more of the Fed policymakers saying, okay, now we’ve gotten policy calibrated, we can we have the opportunity to wait a bit more, see how the economy is evolving, see if the labor market is basically stabilizing, or whether it’s continuing the hearing and how that inform our view.
Disagreement is good it brings differing perspectives 00:07:34:00
So again, I think you’re right. There is difference of opinions on the weight between those two parts of the mandate. And my own view is it’s a healthy to see that kind of disagreement on the Fed, because it is an uncertain environment. It is an uncertain economy. We don’t know exactly how the economy is going to evolve. And in those circumstances, I think it’s good that we have people that aren’t all looking at everything the same way, for sure.
Forecasters were wrong; as the economy was resilient 00:08:19:20
Well, it is kind of remarkable if you think back to the beginning of last year, everyone was thinking that, you know, wow, it’s going to be a weak year. The tariffs are really going to have a bigger impact. We may not see much growth at all. Some I think forecasters were even saying that there’s a high probability of moving the economy, moving the recession and buoy the U.S. economy once again showed its resiliency. It’s always good never to count out the resiliency of the U.S. economy. You know, the, the, the economy, once the statistics are published, you know, looks like it was performing at or above trend last year or not, certainly in recession. And I think there’s good reason to think that there are some tailwinds that’ll support growth next year.
And tailwinds in 2026- 00:09:05:01
So for example, you do have the businesses are going to have that full-expensing of their investment. You have okay. People are going to be I think a bit surprised at the size of their tax refunds that will support consumer spending. Because even though the tax cuts were last year, they didn’t change the whole long tables. And so that I think people will get that and that’ll be supportive of consumption. And I think firms are still going to invest in AI, the data centers and the energy to support that movement in technology. So again, I think there’s a good reason to think that the economy could get through a soft pass patch on the labor market if uncertainty reduces.
Has the tariff affect been mostly played out? 00:09:47:20
And, you know, if the if the tariffs stay stable where they are, I think firms have done some of the adjustment right. We probably will see further price increases because firms have told us, right, that they, you know, in their earnings reports and in other publications that they’re planning to do price increases to cover some of the tariffs that they haven’t put in place yet. So we’ll see that. But, you know, if uncertainty kind of moves down, then we could easily see sort of a better economy next year, which I think generates perhaps some of the forecasts that you were citing in your question.
Fed will take on a more cautious approach now… 00:11:11:20
Well, I think the Fed is going to be very cautious now. I mean, you know, inflation has been above 2% for quite a long time now five years. And you’re right so far the medium to long run inflation expectations haven’t shown movement. They’re in the ranges that are still consistent with 2%. But we have seen movement in the short run inflation expectations.
A very changed future 00:11:36:07
So I don’t think we should count out, that, you know, the Fed is going to have to get inflation back down to 2% to preserve credibility. And we that means it’s going to take somewhat restrictive monetary policy to do it. We’re in an environment now where it could be that the technological changes that firms put in place to address labor shortages during Covid and after Covid, plus the AI technological changes, mean that productivity will be sustained at a higher level than it has been for for many years.
Will that mean higher rates? 00:12:14:15
And that means that the equilibrium rate of interest in the economy, that neutral rate of interest is higher than it’s been. That the two things about that, if productivity is higher the economy can grow faster without generating inflation. But at the same time the interest rate that means the demarcation between a, you know, easy monetary policy and restrictive monetary policy has moved up, which means the Fed has less room to cut rates to get to neutral. So again, the Fed has to be very cautious about continuing to do rate cuts in an environment where R-star, that equilibrium interest rate may be higher than it was, and so little. I think the Fed is going to want to collect some more information about the evolution of the economy before it wants to cut again.
Good news on oil prices could eventually help the Fed 00:13:43:10
Well, I mean, it depends on whether that’s sustainable or not, right? So I think the Fed is not going to be, moving or designing policy based on a short run moving on in oil prices. But eventually, you know, if oil prices do stay lower and the projection is, you know, forecasts are that it’s going to stay lower, that’s going to feed into the Fed forecasts for inflation, right. And probably for growth as well. So again, I think it’s too soon to say you know, whether that’s market movements in oil prices are sustainable or not. The Fed has time to evaluate. It has time to see. It’s a similar kind of question that we often get at the Fed about, you know, if the stock market is, how does the fin react to that? The Fed takes that into account when it thinks about overall financial conditions and whether they’re easy or not. Easy when it when it pertains to monetary policy, there’s also financial stability issues. But for monetary policy purposes it’s really about overall financial conditions, not about one particular price.
The Fed needs to embrace uncertainty 00:15:30:10
Yeah, I mean I think the Fed really needs to embrace the fact that it operates in an environment of uncertainty. And I don’t think that’s anything that they should be afraid of. And in some sense, they shouldn’t shrink from the uncertainty. They should be saying, look, you know, we’re not prescient as a policymaker, but we’re going to behave in a systematic way, right? When the data come in and tell us, you know, this is how the economy’s evolving, we’re going to react in a systematic way. It could be that the data come in and tell us that things are not evolving the way we expected. We’re going to have to incorporate that into the way we do policy making. That means doing more with scenarios, right?
The Fed: from one-trick pony to scenarios? 00:16:09:13
Right now, the Fed is very focused on giving one central view of how the economy is going to evolve, which they have to do, but then they should also be communicating in terms of but if the economy evolves in this alternative way, which is also plausible, then we’re going to react this way. Or if the economy, you know, ends up being that inflation does move down faster than we expected will react or with policy in a different way, I think that would be a good way to communicate.
A dynamic economy will spawn views and views will have to change 00:17:05:14
Yeah, I think that’s a good way to think about it. I think the relevant scenarios would be ones that are helping to export that sort of a difference of views across the members. Right. There are going to be some that think the labor market is going to be stronger and going forward than others, right. Perhaps your view is that as the economy picks back up, as uncertainty around tariffs goes down, that firms will be willing to hire more, and therefore we’ll see that strengthening that would be one scenario. And that would perhaps mean a different policy path than the central tendency, which may see more softening in the labor market at least over the first half of this year.
One forecast from the FOMC?? Plus alternatives…scenarios 00:18:39:14
Under Ben as chair…. He was trying to get a consensus forecast of the committee. Not the staff forecast, because they have their forecasts. But this would be on the committee. And it proved to be kind of complicated to get the committee together. But I think this might be the right time to try to bring that back because, other central banks have forecast some of the forecasts of the stance that they publish, others in the forecasts of the committee. And I think that would be worthwhile, because that would give a coherent view. How is the committee seeing the most likely scenario for the economy, the central forecast? And then what are these alternative scenarios that they think are relative, you know, relatively important in helping formulate their views? The Bank of England in November’s, monetary policy report, they started articulating scenarios.
How scenarios might work and what they offer 00:19:38:03
And, of course, it was interesting that, Ben Bernanke was asked to do the review of the Bank of England. Right. And one of its suggestions was scenarios. And I think it was successful. I mean, I know there are some that think that it could be improved, but I think if you read their monetary policy report, you’ll see that they explain the central tendency. And then they say but there’s an alternative forecast. Right. Where inflation is more persistent, there’s an alternative forecast where you know the labor market is weaker. And those helped kind of articulate the risk around that central tendency in a way that is a coherent narrative… if these things evolve this way, policy may have to be different than our central tendency that we think policy is going to have to do. And I think that would be actually a way of building credibility with the public, because the public shouldn’t hold a central bank accountable for being prescient about how everything is going to work, but they should hold them accountable for reacting in a systematic way should the economy evolve in different ways and those scenarios give the central bank a way of explaining sort of how they’re seeing the economy and alternative views, so that if policy does change, the public doesn’t think, oh, you promised me I was going to do this and this. It’s not that you’re not promising a policy path. What you are trying to do is being very consistent in your reaction function.
Charles Plosser argued that the Fed must tolerate criticism 00:22:19:17
Well, I think Charles was very articulate about accountability. Right. And, you know, the Fed officials are not elected officials and the Fed has to hold itself accountable for its policy. I think the Fed tries to do that. And, you know, part of it is going before Congress. The chair goes before Congress at least twice a year, publishing the monetary policy report, where he tries to explain the policy decisions and opens himself up to questions from Congress, the press conferences, the transparency has increased over the years, in a way that I think is very helpful for accountability. That said, can the Fed do better? Yes. And one of the things I think they can do is every year do a report on how did we do right, what did how did we do? I think the framework review, the fact that they made changes to the strategy, indicates that they didn’t do an internal review.
The Fed may need more self-refection 00:23:21:05
How did policy work during the pandemic? In the post pandemic period where inflation gone up to 40-year highs, I didn’t I know they did a postmortem on that. I think that would be actually helpful for their credibility if they were the ones to release that, rather than waiting for others to criticize. Right. I think you have to be self-reflective, right? And evaluate your own performance and own it. Right, and hold yourself accountable. And I think, Charles, I think, would agree with that. There are things that the Fed could be doing right to hold its itself accountable, rather than allowing others to do that for them. And I think that is probably the best way to preserve the independence of monetary policy from short-run political considerations. If you make policy focused on your dual mandate that Congress has given you maximum employment price stability and then, right, evaluate your performance on achieving those goals and doing that yourself. I think that kind of accountability helps to preserve your independence from short run political considerations.
Fear of fiscal dominance 00:25:04:01
Well, we’re not in fiscal dominance yet. I mean, I think the Fed is focused on its two main goals. It’s able to bring inflation down using its policy tools. And we’ve seen inflation come down right when we were talking about earlier. So it’s not back down to 2% yet. But we have to give credit to the fact that inflation has moved down and the Fed has been having a restrictive policy, at least up to this point. That’s helped to bring inflation back down. But I think there are concerns with the fiscal sustainability of our fiscal situation and the possibility that we’re moving into, dangerous territory on that, that, you know, side of things. And that could lead to a place where monetary policy isn’t able just to focus on its dual mandate goals. Right. It’s not a question of will.
The risk…the threat from the fiscal side 00:25:53:21
It’s just will the fiscal side of the House allow monetary policy right to achieve right price stability? And so if the fiscal side of the House doesn’t get itself in order, right, in a, in a more sustainable position, right, with deficits being, you know, not continuing to move up, especially when we’re not in a recession, we’re not in a financial crisis, that’s going to be a problem.
Challenges ahead not giving up hope for a fiscal solution 00:27:11:13
Well, I mean, there have been solutions proposed in the past that are bipartisan. So I mean, I don’t want to give up all hope for the, because we’ve seen in, in the and, you know, if you look at the Penn Wharton budget model, which is a great resource, if people haven’t looked at it, they should write. They sort of lay out sort of some principles.
How to get fiscal progress…and why we can’t Yellen’s pessimism 00:27:32:17
…When you’re doing this kind of budget, appropriations and then actually put out proposals of how you can get there…. it isn’t that it’s not not doable. It’s just we can’t agree on doing it. When will we get that kind of catalyst to get sort of the agreements that need to go through Congress and the administration? And I think that’s what, Chair Yellen was talking about is, you know, it doesn’t look like we have a Congress, an administration that can work together to get there. And typically what you have seen is that it’s when there’s instability in the financial markets or if some event in the financial market that is the catalyst of that kind of change. And so, you know, I’m, I’m sort of don’t want to rule out that we can’t get there. But I do think that that might have to be the catalyst, which is unfortunate because we have it within our will and power and we just don’t have the will to do it.
Are there any red flags in markets indicating a loss of confidence? 00:28:55:01
I look for those, right? Because, I mean, we saw a little bit of that early in the year last year, in the middle of the year when you saw sort of risk premiums and term premiums on the bond market moving up. Right. You saw set of even central banks moving some of their assets down a dollar. And on this and on gold.. Well, and so that’s the kind of thing you would see is when the public and the markets get skeptical, right, that the fiscal situation in the US is sustainable. Right. You’re going to see that kind of action in both the bond market and in the dollar, exchange rate. And so that would be where I would be looking to see if we have an issue.
So far so good…but that can change very quickly… 00:29:39:04
I don’t think we were there yet. And most in the markets are surprisingly, in some sense sanguine about it. But I think, you know, these are one of these things that can change very quickly. And so that’s where I’d be looking.
The regulatory system has gotten very complex 00:30:15:13
Well, there’s no doubt that the regulatory system has gotten very complex. And I think one of the things that, Vice chair, Bowman is trying to do is trying to simplify it in a way that makes it less complex and doesn’t overburden the smaller institutions that pose less financial risk. Right. And making sure that the regulations that do apply to the large banks actually have the effect of helping them manage the risk and helping us manage the risks of the financial system. So, I think the main idea is probably well founded. Let’s let’s try to make it less complicated and simplify it and make it more coherent - with fewer redundancies. That said, I think we have to be cautious about deregulating in a way that makes the financial system less, stable. And, you know, if we reduce, for example, capital requirements too much, we, we lose sort of the benefits that happened after Dodd-Frank of increasing them.
Regulation can make the economy stronger when things go wrong 00:31:26:16
One of the things that I like to point out is that the banks were in a very strong position going into Covid, which allowed the Fed to sort of temporary relax some of the restrictions so that they could support the economy. You want to be able to have a banking system that’s healthy, right, in normal time, so that it can help the economy through. when the economy really needs some help from the banking system. So again, it’s to everyone’s benefit to have that stability and if they deregulate too much, I mean, and the rhetoric from the administration is not realizing the benefits that you get from the regulation, then I worry about that. The other thing we have to acknowledge is that a lot of the financial system is not in banks anymore.
There are significant financial services and issues outside of banks 00:32:13:13
And so the non-bank financial system, right, non-bank financial institutions are really need to be thought about in a new way in terms of their regulatory structure. And I think that would be something that, I’m sure, Governor Bowman is Nicky’s thinking about in terms of her role in sort of leading that kind of effort.
Next Fed Chair…desired characteristics 00:32:52:21
Well, I think like what? I hope, the new chair will be someone who understands the importance of the Fed making policy decisions focused on dual mandate goals, price stability, maximum employment based on the best economic expertise, modeling, data collection, data interpretation. Right. And really not allowing external things to influence it. So that’s one thing I think it’s important to really sustain that independent monetary policy making capability.
…and listening 00:33:27:23
The other thing is listening, right? Not coming in with like a zealot kind of viewpoint. There’s only one way. But just listen to their colleagues around that table who have very different views on the economy, who have different ways of weighting. Right. The risk around the economy. And, you know, many times when I was at the table, I learned a lot from my colleagues by listening to what their viewpoints are. And so I think that’s what you need in a chair, someone who’s willing to sort of be a leader, be independent, listen, adapt, update, and then lay out the the right path for the committee as a whole.
Loretta J. Mester served as president and chief executive officer of the Federal Reserve Bank of Cleveland from June 2014 to June 2024. In that role, she participated in the formulation of US monetary policy and oversees more than 1,000 employees based at the Bank’s Cleveland office and Branch offices in Cincinnati and Pittsburgh who conduct economic research, supervise banking institutions, promote community development, and provide payment services to depository institutions and the U.S. Treasury. Mester represents the Fourth District on the Federal Open Market Committee (FOMC).
Mester began her career at the Federal Reserve Bank of Philadelphia in 1985 as an economist and was executive vice president and director of research at the Federal Reserve Bank of Philadelphia prior to her appointment as president and CEO of the Cleveland Fed on June 1, 2014.
Mester is an adjunct professor of finance at the Wharton School of the University of Pennsylvania. She has also taught in the undergraduate finance and M.B.A. programs at Wharton and in the Ph.D. program in finance at New York University.
Mester is a director of the Greater Cleveland Partnership, a trustee of the Cleveland Clinic, a trustee of the Musical Arts Association (Cleveland Orchestra), a director of the Council for Economic Education, a founding director of the Financial Intermediation Research Society, a member of the senior council of the Central Bank Research Association (CEBRA), and a member of the advisory board of the Financial Intermediation Network of European Studies (FINEST). She is a member of the American Economic Association, the American Finance Association, the Econometric Society, and the Financial Management Association International.
Mester graduated summa cum laude with a bachelor of arts degree in mathematics and economics from Barnard College of Columbia University. She earned M.A. and Ph.D. degrees in economics from Princeton University, where she was a National Science Foundation Fellow.
Her tenure concluded on June 30, 2024, consistent with Federal Reserve mandatory age and length-of-service policies.